Pier 1 Now A Productivity Story

There is no agreed-upon point where a company is no longer a turnaround story, but there are plenty of anecdotal reasons to believe that Pier 1 (NYSE:PIR) has moved on to become a productivity improvement story. The company has logged several quarters of impressive same-store sales growth, completed a share buyback and begun to talk again about store count expansion and new selling concepts. Still, even if Pier 1 is no longer a true turnaround, investors may well be able to expect quite a bit more fundamental upside as the company couples better merchandising with improved efficiency.

Solid Fiscal Q2 Results For the company's fiscal second quarter, Pier 1 reported that total sales rose nearly 10% to just under $340 million. On a comparable basis, sales grew 10.8% (against a difficult 11.2% growth comp last year). On a per-square-foot basis, sales grew about 10%. Unfortunately, management did not give a detailed breakdown of traffic and ticket trends other than to say that both were positive.

Pier 1 not only sold more wares in the Q2, but did so more profitably. Gross margin improved nearly three full points on basically a one-point increase in merchandise margins. Operating income growth was even more impressive, as the company logged better than a two-point improvement in operating margin and 56% operating income growth.

The Right Mix at the Right PriceRetail sales data have not been especially strong, so it is perhaps odd to think that a seller of non-essentials like Pier 1 should be doing well right now. The reality is that people are still spending, and the retailing game is simply about giving people value for money (or at least the perception of it) and the assortment of goods they wish to buy. It seems simple enough as written, but it is an everyday struggle in the real world.

Making matters more challenging is that some of Pier 1's competition is trying to fight harder on prices. IKEA has been rolling back prices (by double-digit percentages in some cases), and others like Cost Plus (Nasdaq:CPWM) and Bed Bath & Beyond (Nasdaq:BBBY) seem to be more aggressive on promotions and coupons. Of course, there are also "everyday low price" rivals like TJX Companies (NYSE:TJX), Wal-Mart (NYSE:WMT) and Costco (Nasdaq:COST) to contend with for shoppers.

Room for ImprovementWhile Pier 1 may be standing tall in a tough market, it has ample room for improvement. Even if the company hits the consensus estimate for sales in this fiscal year, it will still be at 80% of peak sales (that former peak coming in 2003). Likewise, the current 7% operating margin is a huge improvement from years of ongoing losses, but it's well shy of prior peak margins of 13-14%. Today maybe price competition with IKEA or Bed Bath and Beyond puts those prior margins out of reach, but that still looks like a lot of upside (and remember, this is not an especially healthy or easy economic environment).

Pier 1 can also go quite a bit further on its sales productivity. Compared to Williams-Sonoma (NYSE:WSM), Pier 1 is a laggard. It is not at all reasonable to think that a home furnishings store will get to the rarefied air of a company like Coach (NYSE:COH), Lululemon (Nasdaq:LULU) or Tiffany (NYSE:TIF) (which produces approximately 17 times more sales per square foot). But Pier 1 can still do better, and management seems to be well aware of this and focused on making the improvements.

The Bottom LinePerhaps it sounds daft to hold a retailer of consummately discretionary consumer items in the current environment, but it is difficult to walk away from a hot hand - particularly one that has room for fundamental improvement. Pier 1 does not look too expensive based on current valuation ratios, but neither is it a tremendous bargain. While current investors have credible reasons for holding on, investors who are new to the story can find better bargains and should probably wait for a sale on these shares. (For additional reading, see Turnaround Stocks: U-Turn To High Returns.)